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Thursday, April 7, 2011

Chartwell's Chart: Not So Well

Chartwell Technologies (CWH) designs gaming applications (e.g. slot games, table games) for companies that operate online casinos. Its shares are at an all-time low, going as far back as 12 years ago. The shares are even some 70% lower than they were in March of 2009, which is a dubious distinction usually held by debt-laden companies with serious bankruptcy risk. But Chartwell has no debt against $15 million of cash; and yet it trades for just $11 million.

The company's current assets total $17.5 million against total liabilities of just $1.2 million, giving the company a large discount to its net current assets.

But how is the business doing? Pretty darn good, according to management. In the press release accompanying the company's latest quarterly results, its "highlights" section was comprised of just three bullet points, essentially stating the following:

1) The company expanded its client base
2) The new client has some of the most popular sites around
3) Four new slot games were released

When a company reports only good news and completely omits any financial details in its opening section, investors may read management as lacking candor. Investors who don't read any further than the company's highlights might think this was a growth company trading at a great price. Alas, despite the fact that there was only good news to be found in the "highlights", revenue decreased by 10% (due to the loss of a significant customer), and the company had to pay higher royalty fees such that it couldn't materially reduce costs commensurate with revenues. Furthermore, over the course of the quarter, the company managed to lose $2 million, representing a significant chunk of the company's margin of safety!

Nevertheless, the company is still quite cheap on an asset basis, so can value investors make money? Not without a lot of risk, due to management's rampant optimism. To get the company back to profitability, Chartwell's focus is on growing revenues rather than reducing costs. Both the marketing and sales department budgets have increased, as the company "is
working aggressively to replace the decline in revenue that occurred over the last year."

Chartwell management might very well succeed in its plan to restore revenues to previous levels. However, in so doing, it is risking all that cash that could otherwise be distributed and put towards less risky ventures. Clearly, not all net-nets make for low-risk value investments.